“Government securities are the default safe haven in times of heightened risk aversion. But what happens when Government finances are the cause of the tension? Where are the safe havens then?”

Dylan Grice makes the case that “over time, whats good for the currency and for government finances (bonds) should be good for the rest of the economy (equities) and vice versa.”

The problem is that the last ten years were an outlier, and that goverment bonds have benefited from their “safe haven” status:

The correlation should be positive. Indeed, the following chart shows that the correlation generally has been positive, averaging +0.2 between 1875 and 2002, but -0.3 since 2002 (for the whole period, the average was +0.15). see chart below

Given this outlier status, Investors need to be on the lookout for when government securities lose their safe haven status.

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Sooooo … in the case where Treasuries lose their “safe haven” status, where does money flee? What is the next “safe haven”?

One would think that such an event would necessarily imply a collapse in the US dollar, which, if it occurred slowly, would be accompanied by an increase in inflation (which is not on the horizon at present), making gold a possibility … but if it happened suddenly — as might be the case from a cascading default swap failure (which would likely be global in nature) — what happens then?

In a rapid collapse, gold might spike momentarily, but in a brief time, it too would collapse, as there are no mechanisms to permit exchanges of value, unless Ron Paul cobbled together promisary notes carrying his picture and backed by bullion, an alternative currency of sorts. I’m pretty queasy about anything like that being viable.

So what then? Farmland? Investments in a foreign nation, someplace that would certainly be rocked by a global financial collapse, but that has no substantial risk in and of itself, and has low debt, and a decent economy? Someplace like that would seem likely to recover faster than other places.

Or do we look to something more exotic, like Betelgeusian bonds? Or alternate reality default swaps?

In the current global financial regime, a collapse in US bond worthiness would mean no safe havens anywhere, transaction volume would drop to zero and it would be barter time; e.g., maybe offer a firstborn child for some acreage in corn.

Fortunately the notion that government finances are currently a “cause of tension” in Treasury safe haven status has very little actual substance. It mainly relies upon a defunct macroeconomic model (e.g., the so called treasury view), the fallacy that an economy is a morality play about just desserts rather than an emergent statistic, and/or the inability to escape the metaphor that a creator of a currency (a government) should be analyzed in exactly the same terms as a consumer of that currency (households, municipalities, corporations, etc).

It will take a different global trade regime to change any of this and although that is probably still a decade or two away those alternate reality swaps are something I do keep on my back-burner screen.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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